Remarks by Fed Gov. Ben Bernanke added to the selling pressure, as he told a South Carolina business group that "headwinds have been overcome," said John Canavan, a strategist at Stone & McCarthy. No text of Bernanke's speech was available.

"It's confusing, because all we see are snippets taken out of context," Canavan said of Bernanke's remarks.

Despite the market's reaction, Lehman Brothers economist Drew Matus said Bernanke remained dovish on interest rates. "There is no inflation, there is not likely to be any inflation and policy accommodation can be maintained," Matus said.

Bernanke said that he expected stronger job growth "pretty soon" and that he wouldn't be surprised if the U.S. economy grew at a 4 percent pace or faster in 2004, according to a Reuters news report.

Bernanke also said the fear of deflation has receded, but core inflation rates remain too low. He said the core rate of inflation probably won't rise much this year or next, Bloomberg reported.

Bernanke tempered his optimism by saying "the labor market will improve but probably not very quickly," according to Reuters.

The Fed has "the luxury of waiting" to raise interest rates, Bernanke said, suggesting policymakers could be patient "over the next few months," according to Bloomberg.

Bernanke's somewhat-upbeat comments took on added impact because he's been on the frontlines of the Fed's antideflationary, low-interest rate policy.

Bond investors are typically unnerved by strong economic readings because they can signal mounting inflation risks down the road. Longer-maturity securities are particular sensitive to inflation's effects on their fixed returns.

Short-term notes, meanwhile, decline in price and gain in yield on market perceptions that strong data could force the Fed to raise interest rates sooner rather than later.

Meanwhile, first-time claims for state unemployment benefits were basically unchanged, according to Labor Department data.

The closely watched four-week average of initial claims held steady at 345,250 for the third straight week. It's the lowest level in three years.

The number of initial claims in the week ended Jan. 31 rose by 17,000 to 356,000, slightly higher than forecasts but not by enough to unsettle the outlook for declining claims, said economists. See Economic Report.

Also reported Thursday, productivity in the U.S. nonfarm business sector increased at an annual rate of 2.7 percent in the fourth quarter. It was the slowest increase in productivity in a year. See Economic Report.

Fed policymakers have said a slowing productivity rate could spark new hiring.

"We think this is a clear signal that the cyclical upsurge in productivity is fading, which means, assuming growth is anything as strong as all the leading indicators suggest, employment has to start rising -- fast," said Ian Shepherdson, chief U.S. economist with High Frequency Economics.

The monthly employment report is due for release Friday and will include the government's benchmark revisions to the past several months' data.

For January, the average of a poll of economists by CBS MarketWatch is a payroll gain of 167,000 vs. an anemic -- and unexpected -- gain of 1,000 December. See Economic Preview.

In other trading, the 30-year bond fell 15/32 at 105 21/32. Its yield
TYX, +0.32%
climbed to 4.99 percent vs. 4.94 percent at Wednesday's U.S. close.

Bond investors were digesting global interest-rate news as well.

The European Central Bank left key its interest rate unchanged at 2 percent. Most economists had expected that the ECB would stay steady on interest rates, although growth in countries using the euro remains a laggard vs. the U.S. and Britain.

A minority of economists anticipate the ECB may consider lowering rates to counter the euro's appreciation against the dollar.

The Bank of England, meanwhile, nudged its benchmark rate higher, to 4 percent from 3.75 percent, as a strike against inflation. Read London Calling.

Financial-market attention is also turning to the Group of Seven finance ministers meeting in Florida, although the gathering isn't expected to end in a coordinated policy to support a stronger U.S. dollar.

The dollar's weakness, including a 3 1/2-year low vs. the Japanese yen, has led to currency market intervention by Japanese authorities who are trying to soften the blow to exports from a rising home currency.

Japan has routinely turned its currency intervention proceeds into holdings of U.S. Treasury debt. See Currencies.

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